This blog is a commentary on contemporary business, politics, economics, society, and culture, based on the values of Reason, Rational Self-Interest, and Laissez-Faire Capitalism. Its intellectual foundations are Ayn Rand's philosophy of Objectivism and the theory of the Austrian and British Classical schools of economics as expressed in the writings of Mises, Böhm-Bawerk, Menger, Ricardo, Smith, James and John Stuart Mill, Bastiat, and Hazlitt, and in my own writings.

Sunday, January 27, 2008

Today, in the world of financial celebrity, anyone who is anyone is a billionaire. By the same token, millions upon millions of people are or soon will be mere, everyday millionaires in the United States. Millionaires are on the way to becoming a dime a dozen.

Similarly, new cars cost what new homes did only a few decades ago. Men’s neckties often sell nowadays for as much as men’s suits did not so very long ago. To have a pair of soles and heels put on a pair of shoes today costs as much as a new pair of shoes did not too many years ago.

All of this is the result of continuous inflation of the money supply by the Federal Reserve System. As a result of the “Fed’s” actions, tens and hundreds of billions of new and additional dollars have poured into the economic system, correspondingly increasing spending and driving up prices. There are more and more billionaires and millionaires and shockingly high-priced goods simply because of the flood of new and additional money coming from the Fed.

It’s not such things as “oil shocks” or diverting food crops to fuel production that’s responsible. Without the flood of new and additional money, increases in the price of oil and farm products would be accompanied by decreases in the price of practically everything else. This is because practically all of whatever additional money was spent in buying oil et al. would have to be taken away from spending elsewhere, since the overall total ability to spend in the economic system would be limited by a limited quantity of money. And the rise in the price of oil and farm products would also not be nearly as great as it has been.

To confirm the fact that the source of today’s high and rising prices lies in the rapid increase in the supply of paper currency and checkbook money, it’s helpful to calculate prices in terms of the currency sanctified by the U.S. Constitution, namely, the gold dollar. A gold dollar contains approximately one-twentieth of an ounce of gold. Today an ounce of gold sells for more than $800 (it’s actually more than $900 at the present moment). That means that one gold dollar has the value of more than $40 paper dollars, because one-twentieth of $800 is $40. The result is that the price of everything stated in gold dollars is currently one-fortieth, or less, of its price in paper dollars.

Thus, a $1million home is $25,000 in gold dollars. A $50,000 automobile is $1,250 in gold dollars, and so on. The rise in prices is the result of the fact that we express prices in paper money, whose supply can be increased virtually without limit and without cost. Prices can never rise to anywhere near the same extent when stated in gold. That’s because gold is rare in nature and costly to extract.

Today, we have a credit crisis emanating from the collapse of the real estate bubble that the Fed launched in order to cope with the effects of the collapse of the stock market bubble that it had launched only a few years earlier. Now, in order to cope with the effects of the collapse of the real estate bubble, the government and the Fed are looking for yet another program of monetary “stimulus.” This time it’s to be in the form of cutting taxes while financing an undiminished, indeed, an increased amount of government spending by means of the creation of still more new and additional money.

The Fed and the rest of the government seem to think that their job is always to be sure that the stock market averages and the price of homes is never to be allowed to fall too far below their most recent peaks, and to flood the economy with as much new and additional money as may be required to accomplish this. Keeping up housing prices is an especially remarkable goal, inasmuch as only a year or two ago, all of the complaining was about how far housing prices had climbed relative to the ability of people to afford them. One would think that a sharp reduction in home prices is the very thing needed to solve that problem and that the process needs to go a good deal further than it has, in order to do so.

For the present and the foreseeable future, there is probably nothing that will stop the Fed from continuing with its inflation. Leading pressure groups are ardently in favor of it: tens of millions of share owners want it; the great majority of businessmen large and small want it; bankers and brokers want it; homeowners want it; labor unions want it; the political establishment wants it. If there is another terrorist attack, let alone another war, inflation will be used to pay much of the cost. To the extent that the environmentalist agenda of declining energy production is imposed, inflation will be used to finance subsidies to the growing numbers of Americans who will be impoverished by it. Their expenditure of those subsidies will drive up prices for everyone else and cause further impoverishment and the need for more subsidization and for still more inflation to pay for it.

In the face of such prospects, people around the world who have been willing to hold dollars because dollars were superior to their own, more rapidly inflating currencies, will lose their desire to hold dollars. They’re already losing that desire. The world’s supply of dollars will sooner or later reside exclusively in the United States. Indeed, the reflux of dollars appears to have already begun.

The dollar has begun the kind of slide taken in the past by such currencies as the Italian lira. In the 1930s, one lira was worth 20 cents. Twenty cents in that era had a buying power equal to several of today’s dollars. Before the lira was replaced by the euro, its value was less one-twentieth of one U.S. cent. A few days food and lodging at an undistinguished hotel cost more than a million lira. The fall of the lira took place in essentially the same way that the dollar is falling today—through the reckless increase in its quantity in response to widely held beliefs in the necessity of such increase.

Is there anything that can be done to stop the potential destruction of the real value of all dollar-denominated savings and long-term contracts by a flood of inflation? Is there anything that can protect people from a possible tsunami of inflation in the United States?

There is something that could be done. There is a financial life raft, as it were, that could be made available to everyone, that would enable people to salvage at least some significant portion of the real value of their savings and contracts denominated in fixed sums of dollars. It is something much more urgently needed, aimed at a much more realistic danger, and much more feasible than efforts to control global warming, say.

What is it? It is the enactment of a creditors’ protection bill, whose essential provisions would be the insertion into all outstanding contracts of a limited, contingent gold clause, and the removal of all legal obstacles to the inclusion of such clauses in all future contracts.

Here’s an example of how it would work. Imagine someone who owns $1 million of corporate bonds that he bought several years earlier and that are scheduled to be redeemed in another 25 years. Perhaps 25 percent of this sum, i.e., $250,000, would be designated as representing the quantity of gold that the owner of the bonds could choose to receive when the bonds came due, instead of the $1 million he is presently entitled to receive at that time. The actual quantity of gold he would be entitled to receive would be the amount that $250,000 could buy at the price of gold prevailing on some specified date within 12 months prior to the enactment of the law.

If that price of gold were $1,000 per ounce, say, then the $1 million dollar contract would contain a contingent liability calling for the payment of 250 ounces of gold. This payment would be at the creditor’s option. The creditor would have the right to choose to be paid 250 ounces of gold rather than $1 million dollars.

Obviously, no creditor would exercise this option if the price of gold remained at $1,000 per ounce, let alone if it fell below $1,000 per ounce. He would not exercise it if the price of gold rose to $2,000 per ounce. Nor would he do so if it rose to $3,000 per ounce. But when and if the price of gold exceeded $4,000 per ounce, then it would be to the advantage of the creditor to choose to be paid 250 ounces of gold, or the sum of dollars then necessary to buy 250 ounces of gold, for at that point 250 ounces of gold would represent more than $1 million.

If when gold reached, say, $5,000 per ounce, the 250 ounces of gold that the creditor was entitled to would be worth $1,250,000, i.e., $250,000 more than the million he had lent. This would not represent any real gain to the creditor, however, if over the same period of time, prices in general had also increased by a factor of 5. In that case, the actual buying power of the 250 ounces of gold would be no greater than it had been when the price of gold was $1,000 per ounce and prices in general were where they were at that time.

But even in this case, the creditor would not be quite as badly off as he would have been without the protection afforded by the 25 percent gold clause. For in its absence, he would have been repaid merely his original $1 million, that now had a buying power only one-fifth as great as it was originally. With this gold clause and his consequent receipt of $1,250,000, the buying power he receives is one-fourth as great as the sum he lent.

The difference between a fourth and a fifth is, of course, not very great. It would amount to our creditor incurring a loss in buying power of 75 percent rather than 80 percent, which is not an outcome to be particularly happy about.

But the odds are great that the protection afforded by such a gold clause would be equal to more than 25 percent of the real value of the sum originally due the creditor. This is because if prices were to start rising rapidly, the price of gold would almost certainly rise even more rapidly. Thus, for example, if prices in general were to rise on the order of 5 times over the course of a decade or two, say, the price of gold might very well rise by 10 or even 20 times. In that case, the 250 ounces of gold that the creditor would have the option of choosing, would be worth $2.5 million or even $5 million. In the face of a fivefold rise in prices, these sums would have the buying power of 50 percent or even 100 percent of the real value of the sum originally due the creditor.

What would serve to make the price of gold rise faster than prices in general is that in periods of rapid inflation, and in the absence of any reliable alternative paper currency, such as the dollar once appeared to be, gold is the ideal inflation hedge for most people. Even though its ownership entails some costs of storage and safekeeping, those costs are very modest. At the same time incurring them represents a far lesser loss than does practically all the usual forms of investment in a period of rapid inflation, including ownership of common stocks and family businesses. In these cases, capital gains taxes and income taxes consume funds needed for replacement at higher prices. As a result, a growing demand for gold as an inflation hedge appears, which operates on the price of gold alongside of and in addition to the forces operating to raise prices in general. In addition, the price of gold could be increased by the desire for accumulations of gold on the part of those who had agreed to accept contingent liabilities in gold.

A potential consequence of a system of such partial gold clauses could well be the development of substantial opposition to rapid inflation on the part of debtors, however paradoxical that may sound. This is because once the number of dollars payable under gold clauses started to exceed the number of dollars originally owed, debtors would be in a position in which further inflation served to increase their burden of debt rather than decrease it. Gold prices rising more rapidly than prices in general would mean that debtors would be in a position in which the additional inflated money they took in could not keep pace with the additional money they owed. They would do better to take in less additional inflated money and not be confronted with debt obligations rising even more rapidly. (This seemingly paradoxical effect of inflation under a system of gold clauses is a matter I discuss more fully in Capitalism.)

Enactment of a creditors’ protection bill along the lines I have described should be an essential part of the near-term political agenda of all defenders of economic freedom. It would offer a potentially valuable two-fold protection against the ravages of inflation. First, it could provide substantial protection to the real value of the assets of individuals. Second, it also might also ultimately turn debtors, who typically have a vested interest in inflation, into opponents of inflation, once they came to be faced with debts payable in gold, which would become harder to repay as inflation reduced the ability of paper money to serve as the means of repayment.

The insertion of a gold clause into existing contracts should by no means be regarded as any kind of new and additional government interference with the freedom of contract. To the contrary, it would be a major step in undoing such interference. Prior to their abrogation by the New Deal in 1933, full, 100 percent gold clauses were the norm in the United States in long-term term debt contracts, and had been since the Civil War. They are something that comes about on the foundation of the rational self-interest of individuals when it is allowed to operate free of government interference.

Obviously, the degree of gold clause protection would not by any means necessarily have to be the 25 percentage points that I have chosen for purposes of illustration. If a mere 5 or 10 percent protection could be enacted into law, it would be a major first step, simply by introducing the concept of gold clauses to the present generation. And, of course, it would still afford some actual measure of protection against the possible ravages of inflation.

The parties entering into new contracts should be free to include whatever degree of gold clause protection that was mutually agreeable. What presently stops such contracts from being made are considerations both of their enforceability in the courts and their likely treatment for purposes of taxation. As just mentioned, such contracts were abrogated on a mass scale in 1933 and the Supreme Court did nothing to uphold them. To be accepted with any degree of confidence, the enforceability of new, partial gold-clause contracts would have to have the benefit at the very least of a joint resolution of Congress directing the courts to uphold them.

The gold-clause contracts would have to be exempt from any possible application of usury statutes. Such statutes might come into play when creditors ended up being repaid sums of depreciated paper dollars that were greatly in excess of the sums originally lent—e.g., being repaid $2.5 million paper dollars when one had originally lent $1 million paper dollars. The contracts would have to be interpreted in terms simply of being repaid a fixed amount of gold principal—e.g., the 250 ounces of gold in the example above—irrespective of any increase in the price of gold.

Treatment of the gold-clause contracts in this way, would preclude the payment of taxes on any paper money gains reflecting merely the repayment of larger sums of paper to maintain parity with the same physical amount of gold. Thus, for example, the $1.5 million paper gain in the repayment of $2.5 million on a $1 million loan would not be subject to any kind of income or capital-gains taxation. The applicable principle would be that the lender has merely received the same physical quantity of gold that he was always entitled to. He has no gain whatever in terms of gold. In effect, he has lent a sum of gold and has been repaid that sum, nothing more. Thus, he has no gold income or gold capital gain.

Gold-clause contracts would almost certainly become very widespread if the market could take for granted their enforceability and exemption from taxation based merely on the rise in the price of gold.

As a matter of principle, the parties entering into new contracts should be legally free to agree to whatever degree of gold-clause protection they wished, all the way to 100 percent. Nevertheless, little actual harm would likely be done, if for a short time legal limits were imposed on the percentage of the value of new contracts that could enjoy gold-clause protection. Such a limitation would probably make the enactment of gold-clause protection politically more acceptable in the beginning, since it would be an incremental change and thus not appear too radical. Even with such a restriction, the gain simply from enacting the principle of gold-clause protection would be profound, not to mention the substantive protection likely afforded to creditors.

However, even in the absence of any legal limitation, for some period of time it would almost certainly be highly advisable in most cases for the contacting parties to agree to fairly modest partial gold clauses rather than full, 100 percent gold clauses. This is because partial gold-clause protection is what will be necessary in order not only to give creditors an important measure of the protection they need, but also to avoid the development of widespread bankruptcies on the part of debtors.

The threat of debtors going bankrupt arises because continuing inflation is likely to drive the real value of gold far higher than it is today and at the same time greatly reduce the ability of earnings in paper money to pay debts stated in gold. As a result, entering into 100 or even 50 percent gold-clause contracts today, at today’s price and real buying power of gold, would be an extremely risky proposition for debtors, one likely to result in their owing amounts of gold they simply could not pay.

Avoiding near-term widespread bankruptcies in gold is essential to gaining public support for gold’s once again serving to protect the real value of contracts on a large scale. Hopefully, education about the risks of owing too much gold would serve to prevent bankruptcies in gold from being too frequent. Partial gold-clause protection is what would follow from such education and accomplish its objective.

The implication here is that the degree of gold-clause protection in contracts should increase only as the risk of further increases in the real value of gold in the economic system relative to that of paper money declines.

Gold-clauses, of course, would protect not only lenders, but also people dependent on pensions or annuities or who would be the beneficiaries of such retirement vehicles in the future. They would also protect the grantors of long-term leases of all kinds.

The widespread establishment of partial gold clauses is an essential step in the protection of the buying power of creditors. It would also be a major step on the path toward the establishment of sound money.

Of course, it is possible that the Fed will pull back from its increasingly inflationary course and reverse field as it did in the early 1980s. In that case, gold-clause contracts will simply have a status comparable to fire insurance for people whose homes do not suffer fire damage greater than their deductible. They will serve simply as a form of insurance policy. One that, unfortunately, looks like it is increasingly needed.

Saturday, January 12, 2008

Capital in the form of credit is normally and, certainly, properly, extended out of previously accumulated savings. In sharpest contrast, credit expansion is the creation of new and additional money out of thin air, which money is then lent to business firms and individuals as though it were a supply of new and additional saved up capital funds. Its existence serves to reduce interest rates and to enable loans to be made and debts to be incurred which otherwise would not have been made or incurred. Always and everywhere, to the extent that private banks participate in the process of credit expansion, they do so with the sanction and generally with the active encouragement of the government.

Economists, above all Ludwig von Mises, have shown how credit expansion is responsible for the boom-bust business cycle and how its existence depends on deliberate government policy. Nevertheless, public opinion believes that the business cycle is an inherent feature of capitalism and that the role of government is not that of causing the phenomenon but of combating it. Indeed, as Mises observed, “Nothing harmed the cause of liberalism [capitalism] more than the almost regular return of feverish booms and of the dramatic breakdown of bull markets followed by lingering slumps. Public opinion has become convinced that such happenings are inevitable in the unhampered market economy.”

The truth is that credit expansion is responsible not only for the boom-bust cycle but also for another major negative phenomenon for which public opinion mistakenly blames capitalism. Namely, sharply increased economic inequality, in which the wealthier strata of the population appear to increase their wealth dramatically relative to the rest of the population and for no good reason.

It is not accidental that the two leading periods of credit expansion in history—the 1920s and the period since the mid 1990s—have been characterized by a major increase in economic inequality. Both in the 1920s and in the more recent period, a major cause of the increased economic inequality is that the new and additional funds created in credit expansion show up very soon in the financial markets, where they drive up the prices of securities, above all, common stocks. The owners of common stock are preponderantly wealthy individuals, who now find themselves the beneficiaries of substantial capital gains. These gains are the greater the larger and more prolonged the credit expansion is and the higher it drives the prices of shares. In the process of new and additional money pouring into the financial markets, investment bankers and stock speculators are in a position to reap especially great gains.

Since it’s so important, the main point just made needs to be repeated: credit expansion creates an artificial economic inequality by showing up in the stock market and driving up stock prices. Since the stocks are owned mainly by wealthy people, they are the main beneficiaries of the process. The more substantial and the more prolonged the credit expansion is, the larger are the gains enjoyed by wealthy people more than anyone else.

The new and additional funds injected into the economic system also soon show up in an additional demand for capital goods, such as business inventories and plant and equipment, and in an additional demand for consumers’ durable goods, such as houses and automobiles. The purchase of these latter goods, like the capital goods purchased by business firms, depends largely on credit and is encouraged by lower interest rates. It is also fed by the capital gains being reaped by wealthy individuals, which results in an especially pronounced increase in the demand for luxury housing and for luxury goods in general.

The additional demand for capital goods and consumers’ durable goods serves to increase business sales revenues and thus business profits across a wide spectrum of the economic system. Credit expansion increases profits in the economic system because the expenditure of the new and additional money in buying capital goods and labor increases the sales revenues of business firms immediately, while it increases the costs they must deduct from those sales revenues only with a time lag. This is also true to an extent of inflation that enters the economic system by means of its creators simply spending the new and additional money rather than lending it out—“simple inflation,” as Mises calls it. What is present in both kinds of inflation—credit expansion and simple inflation—is the fact that sales revenues rise as soon as new and additional money is spent, but the costs deducted from the sales revenues of any given year largely reflect outlays of money made in previous years. In those previous years the quantity of money and volume of spending of virtually all types was smaller, including the spending that shows up in the present year as costs in business income statements.

Credit expansion boosts profits more than does simple inflation because the reduction in interest rates it brings about serves to increase the time lag between the making of expenditures for capital goods and labor and their subsequent appearance as costs in business income statements. The low interest rates encourage the purchase of such things as durable machinery and the undertaking of construction projects. The kind of increase that this must bring about in economy-wide profits can be seen in the following examples.

Thus in one case, imagine that a business firm uses newly created money that has come into its hands to increase its newspaper advertising, say. Its additional expenditure will be equivalent additional sales revenue to the newspaper. It will also most likely be an equivalent immediate additional cost to it—a cost that it must deduct from its sales revenues in its very next income statement. Thus, in the same accounting period that the newspaper records additional sales revenues equal to the firm’s additional expenditure, the firm itself must record an equal additional cost of production to deduct from its own sales revenues. Obviously, in this case there is no increase in the economy-wide aggregate amount of profit. This is because economy-wide, aggregate sales revenues and economy-wide aggregate costs have both increased to the same extent.

But now imagine that the firm spends the same amount of money in buying durable machinery that will be depreciated over a ten-year period. Once again, a seller, this time the seller of the machinery, will immediately have additional sales revenues equal to our firm’s additional expenditure. But in this case, our firm will certainly not have an equally large additional cost of production to report in its next income statement. If its expenditure for the machinery was $1 million, say, then while the seller has $1 million of additional sales revenues in his next annual income statement, our firm will probably have merely $100 thousand of additional costs to report in its next annual income statement. This is because the purchase price of the machine is not charged off all at once, but only gradually, over its depreciable life. The implication of this example is that in the current year there will be an addition of $900,000 to economy-wide, aggregate profits. If our firm’s $1 million were part of an investment in the construction of a building with a forty-year depreciable life, the implied addition to economy-wide, aggregate profits would be even greater.

Such boosts to profits go hand in glove with the rise in common-stock prices and greatly reinforce them. Of course, once credit expansion comes to an end, the stimulus it gave to profits and to the stock market both disappear and at that point profits plunge and capital gains turn into capital losses. And at that point, the enemies of capitalism turn to attacking capitalism for causing depressions.

Now as the new and additional money created in credit expansion works its way through the economic system, one would expect the demand for labor and thus wage rates also to rise. This certainly does tend to happen and in the 1920s wages increased substantially in terms both of money and real buying power. They simply did not increase to nearly the same extent as the incomes of the wealthier strata of the population, nor, of course, to the extent that business profits increased.

In addition to the special stimulus given to profits, a second reason for the failure of wages to keep pace with the rise in profits, is that the encouragement given by credit expansion to the purchase of durable capital goods, particularly plant and equipment, tends to take place at the expense of funds that otherwise would be devoted to the purchase of labor services. As a result, the rise in wages is retarded at the same time that profits sharply advance. For this reason too it does not keep pace with the rise in profits.

Despite any appearances to the contrary, the rise in real wages in the 1920s was not the result of credit expansion but of rising production. Credit expansion actually operated to retard the rise in production insofar as it caused the wasteful investment of capital, i.e., what Mises calls malinvestment.

The rise in production is what prevented the prices of goods and services from rising as rapidly as credit expansion raised wage rates in terms of money. The rise in production, in turn, was based on a high degree of availability of capital funds provided by actual savings, as opposed to credit expansion, together with rapid scientific and technological progress. It was this that increased real wages, i.e., the goods and services that wage earners could actually buy with their wages.

In contrast to the experience of the 1920s, in the two great recent credit expansions, i.e., the dot.com bubble of 1995-2001 and its successor the presently collapsing housing bubble that began not long thereafter, there has been very little, if any, rise in real wages. Most commentators appear to attribute this to nothing more than the unrestrained greed of businessmen and capitalists. They apparently go on the theory that if there is anything in the economic system that breathes or moves other than at the command of the government, or other than with the active supervision and control of the government, it is proof that we live in an era of “laissez-faire.” For example, in The New York Times of December 30, 2007, in an article titled “The Free Market: A False Idol After All?,” Times columnist Peter Goodman writes:

For more than a quarter-century, the dominant idea guiding economic policy in the United States and much of the globe has been that the market is unfailingly wise. So wise that the proper role for government is to steer clear and not mess with the gusher of wealth that will flow, trickling down to the [sic] every level of society, if only the market is left to do its magic.

That notion has carried the day as industries have been unshackled from regulation, and as taxes have been rolled back, along with the oversight powers of government.

This alleged laissez-faire environment, such writers pretend, has enabled businessmen and capitalists shamelessly to enrich themselves at the expense of increasingly impoverished wage earners, to whom nothing any longer even “trickles down.” Increased free trade and “globalization,” of course, are attacked as part of the process and as greatly contributing to the stagnation or outright decline in real wages.

In sharpest contrast to such blather, in the real world there are innumerable rules and regulations enacted by the Federal Government to control virtually every aspect of economic activity. They are contained in the more than 70,000 pages of The Federal Register. The overwhelming mass of government interference described therein, and in its counterparts at the state and local level, is a glaring refutation of claims about the existence of any kind of laissez faire in the present-day world. The very description of such interference, in tens of thousands of pages of official text, is a refutation of such size and literal weight as to render any claims about laissez faire or insufficient government controls or regulations utterly nonsensical.

This truly massive body of material also suggests that the actual explanation of the stagnation in real wages is precisely an ever growing burden of government intervention in the economic system. The intervention is in the form of policies that undermine genuine saving and in numerous other ways undermine capital accumulation and the rise in the productivity of labor. Personal and corporate income taxes, the inheritance tax, the capital gains tax, and government budget deficits—all entail the taking away of funds that if left in the hands of their owners would have been heavily spent, indeed, overwhelmingly spent, in the purchase of capital goods and labor services. Instead, those funds are diverted into financing the consumption of the government and those to whom the government gives money.

Inflation and credit expansion greatly exacerbate this diversion of funds, because their effect is artificially to increase the incomes subject to these taxes and to thus to deprive business firms of the funds required to replace assets at prices made higher by the same process that increases their taxable incomes. The progressive aspect of income and inheritance taxes also worsens their effects, because incomes tend to be saved and invested the more heavily the larger they are; at the same time, substantial inheritances are more likely to be retained in the form of accumulated savings and capital than are modest inheritances.

Because of the reduced demand for labor that results from the taxation of funds that would otherwise have been used in employing labor and in buying capital goods, wages are substantially less than they otherwise would have been. At the same time, the buying power of those reduced wages is also sharply reduced in comparison with what it would otherwise have been.

It is worth pointing out that totally apart from the effect of social security in undermining the incentive to save, the sheer rise in tax rates since 1965 to pay for the system has taken away fully eight additional percentage points of the income of every wage earner whose earnings are equal to or less than the amount subject to such taxation. In 1965 the combined social security tax on wage earners and their employers was 7.25 percent, which applied to a maximum annual income of $4800. Today, the combined rate is 15.3 percent, which includes 2.9 percent for Medicare. The 15.3 percent rate currently, i.e., in 2008, applies to all wages and salaries up to a maximum of $102,000 per year. The effect of these major increases both in social security tax rates and in the amount of incomesubject to them has been to reduce the take-home wages of many workers by considerably more than 8 percent.

The social security contribution of employers is a loss to wage earners, because it is a cost of employment no different than the payment of take-home wages. Financially, it is a matter of indifference to employers whether they pay this sum to the government or to their employees. The cost to them is the same. It is money that the employees could and would have had, if the government had not taken it from the employers.

The same is true of all other costs borne by employers on behalf of their workers, whether it is health insurance, day care, family leave, or whatever. The costs in question are all costs of employment, which, in the absence of such government interference, the wage earners could and would have had in their own pockets. Compelling employers to pay the costs of such things is at the expense of the workers’ take-home wages. The more such costs are imposed, the lower are take-home wages in comparison with what they otherwise would have been. The increase in such costs over time has correspondingly held down any rise in take-home wages.

Government intervention, as I’ve said, not only holds down the demand for labor and thus wages, particularly take-home wages, but it also reduces the buying power of wages. This is because the supply of capital goods is less, thanks to the diversion of funds from their purchase. The absence of these capital goods prevents the productivity of labor from being increased as much as it otherwise would have been. This in turn holds down the production both of consumers’ goods and of further capital goods. The consequence of a lesser supply of consumers’ goods is prices of consumers’ goods that are higher than they otherwise would have been and thus a buying power of wages that is correspondingly lower than it otherwise would have been.

The consequent absence of further capital goods compounds the negative effect on production, in a process that can be repeated over and over again, with each passing year. What this means is that because fewer capital goods in the form of factories and machines are available this year, the ability to produce capital goods in the form of factories and machines for the following year is reduced, because capital goods in the form of factories and machines are the means of producing further capital goods in the form of factories and machines no less than they are of producing consumers’ goods.

The buying power of wages is also reduced by all of the other laws and regulations that hold down the production and supply of goods in general and thus keep up prices. And again, there is a compounding effect. Environmental legislation deserves an especially prominent place in any list of such laws and regulations. Already, because of the restrictions it has imposed on the production of oil, coal, natural gas, and atomic power, it has served to raise the price of energy to unprecedented levels and to deprive many wage earners of the ability to buy gasoline for their cars or trucks and heating oil for their homes. To the extent that wage earners are able to pay energy prices reflecting a $100- per-barrel price of oil, their ability to buy other goods is correspondingly reduced. If the environmental movement’s agenda of radical reductions (up to 90 percent) in carbon dioxide emissions is imposed, meeting it will require absolutely crippling cutbacks in the production and use of oil, coal, and natural gas which must result in corresponding reductions in production, increases in prices, and absolute devastation for real wages.

The negative effect on production here is again a cumulative one, inasmuch as lack of energy supplies hampers the ability to find and exploit further supplies of energy. The more abundant and cheaper energy is, the greater is man’s ability to move masses of earth and to process them, thereby developing further energy supplies. Thus, government intervention that reduces energy supplies reduces the ability to find and exploit further energy supplies.

Other examples of laws and regulations holding down production are minimum-wage, prounion, and licensing legislation. These cause higher costs, higher prices, the diversion of labor from more productive pursuits to less productive pursuits, and, finally, unemployment. Subsidies of all kinds, tariffs, and consumer-product safety legislation also serve to hold down the production and supply of things and to keep up or add to their costs and prices. Again, to whatever extent production in general is curtailed, so too is the production of capital goods, with a consequent cumulative negative effect on subsequent production.

It should be clear that the resumption of an era of high and progressively rising real wages requires a radical reduction of government intervention into the economic system and the reestablishment of economic freedom.

What we have seen is that credit expansion is responsible not only for the boom-bust business cycle, as Mises showed, but also that it is a major source of artificial economic inequality and sharply increases profits relative to wages. These are processes that come to an end and are actually thrown into reverse as soon as credit expansion stops and the recession/depression that is its ultimate consequence begins. In wasting capital through malinvestment, it undermines the rise in production and accompanying rise in real wages. Despite credit expansion, real wages could still rise through most of American history, because of the substantial economic freedom enjoyed in the United States and did so even in the midst of credit expansion, as in the 1920s. In the last two episodes of major credit expansion, however, and over the last several decades as a whole, real wages have largely stagnated. This stagnation is the result of massive government intervention into the economic system that undermines capital accumulation and both the demand for labor and the productivity of labor. It is not the result of economic inequality, the profit motive, or any other aspect of the capitalist system.

I have explained all of the essential matters discussed in this article in full detail, with all of their presuppositions and implications, in my book Capitalism: A Treatise on Economics.